Competition from China is only going to
intensify, so the developed West needs to stop
whining and embrace it. While the United States
and Europe are addressing China's rise
differently, neither has any alternative but to
take up this challenge.
The US consumer
has been the primary recipient of cheap Asian
imports. US policymakers have fostered consumption
through monetary and fiscal policies, ie through
low interest rates and low taxes.
US
policies have accelerated Asia's growth; while the
intent of US policies has been to foster US
growth, there have been serious unintended
consequences. Notably, the stimulatory economic
environment - which has also been fostered by most
Asian states subsidizing their exports through
pegged, low exchange rates -
has
caused a shortage of commodities worldwide, high
commodity prices, and low consumer-goods prices.
Corporate America, faced with high
commodity prices and an inability to pass on
higher costs, had to accelerate its outsourcing to
retain margins. The pressures have directly
contributed to disappointing job and real wage
growth.
As the US has pushed growth while
dismantling its manufacturing sector, its
current-account deficit exploded to more than
US$800 billion in 2005, or more than 6% of gross
domestic product; foreigners need to finance the
current-account deficit at a rate of more than $2
billion every day, just to keep the US dollar from
falling.
In Europe, consumers have
increased savings in recent years, as they were
reluctant to spend in a challenging economic
environment. Asia is knocking on the doors of
European consumers, and corporate Europe is
feeling the pinch.
Whereas the US economy
is known for its flexibility, Europe is known for
its rigidity. Corporate Europe has been unable to
adjust quickly enough to compete with China
effectively. Many Europeans believe it is
impossible to compete with "low-cost China" and
that protectionist measures must be taken to
"preserve" European culture.
The recent
protests by French students reflect a fear many
Europeans share that they don't want to give up
their many social benefits - including job
security. Europeans see China as a threat to their
culture: they are scared they will have to adopt a
Chinese lifestyle.
However, it is time to
get rid of one myth: China is not a
low-cost country. True, China is a low-wage
country, but wages are only one component of the
costs faced by manufacturers, and not only that, a
bidding-up of wages in the booming coastal areas
in recent years shows that Chinese wages do obey
the laws of economics in spite of the country's
huge population. Producers in China also face the
same high raw-material prices as the rest of the
world; many regions in China face high
transportation costs (which further increase
raw-material prices); the still-underdeveloped
infrastructure in much of China increases the cost
of doing business; and China's opaque,
unpredictable regulatory/bureaucratic environment
further burdens its producers.
And
notably, competition within China is utterly
cutthroat. It is not merely that the Chinese seem
to be competitive by nature, but rather,
pro-growth policies ranging from pegging the yuan
to the US dollar to easy access to loans and other
government policies have created too many
businesses chasing each and every opportunity.
Successful investors in China understand
the opportunities and challenges of the region.
Investments in highly efficient, scalable
enterprises make sense assuming there is demand
for the products produced. They need to be
large-scale investments to overcome high fixed
costs and to operate profitably with a
high-volume, low-margin business model.
Investors in China take great care to have
highly defined production processes with great
emphasis on quality control. The attention to
quality control recently has been one result of
China's reputation for poor-quality goods a decade
ago.
How times have changed! A low-skilled
Chinese worker today may produce more consistent
quality than a highly skilled Eastern European
worker. Partly because quality is less of a
concern with a highly skilled worker, less
emphasis is placed on production automation and
quality control in much of the West.
The
Chinese approach is more scalable and - at the end
of the day - may yield superior quality. Also,
note that a couple of hundred thousand highly
qualified engineers are entering the workforce
every year in China.
Indeed, the Chinese
are gradually realizing that even they cannot
compete on cost alone - investors concerned
primarily about cost are moving to cheaper places
such as Vietnam. Instead, China is working
feverishly - and successfully - to service the
later stages in the value chain.
The way
to respond to such a competitive challenge is to
learn and adjust your own way of doing business.
But that does not mean Americans and Europeans
have to work at Chinese wages.
The US has
the great advantage that it has a highly flexible
economy. Unfortunately, well-intended but mistaken
policies have pushed the US economy toward
consumption and debt rather than investments. The
US is now in such a weak position that no
policymaker dares to call for changes that foster
savings and investments rather than consumption;
such policies may induce a severe recession in the
short term. Yet this may be precisely the medicine
the US needs if it wants to prevent the risk of
ever-increasing pressure on the dollar as the
current-account deficit escalates.
The
rise of gold and the dollar's weakness over the
past couple of years are warning signs of what may
come should there not be a change in policies.
Given the high consistency in fiscal and monetary
policies in the US, we have little faith that such
policies will be instituted.
Europe -
because of its relatively high consumer savings -
is structurally in a stronger position to compete
with Asia. However, rigid European structures are
preventing corporate Europe from arming itself for
competition. Executives waste time arguing over
social benefits and wrangling with bureaucrats and
local activists instead of focusing on
repositioning their businesses to compete in a
constantly changing world.
If the West
does not want to adopt Asian wages, it must
compensate by providing incentives, rather than
obstacles to investment. The West must think of
itself as being a couple of steps ahead of the
Chinese in the value chain, and vigorously defend
that position by constantly reinventing itself.
Reality must be faced: there are certain types of
jobs that cannot survive in Europe. But there are
also certain jobs that cannot survive in China and
have moved to Vietnam.
In the US, most
agree that job guarantees like those the French
students have been fighting for are bad for
business. A company does an incompetent employee a
favor by laying him or her off, so that he or she
can find a more suitable job rather than wearing
the company down in a dead-end career. Many
Europeans think differently: it is inhumane to use
an employee like a pawn; an employee must be able
to plan to have a family and life.
A
capitalist may counter that it is an inefficient
allocation of resources to pursue the European
model, and that the threat of losing a job may be
an incentive to work harder.
Our
interpretation is more moderate: we argue that the
best companies attract the best employees; many
successful large enterprises pride themselves in
low employee turnover - not because it is the law,
but because they provide a morale-fostering and
thereby more productive environment for their
staff.
Workers who seek job security
should work for companies that offer it. But the
companies that want to adapt should not be held
back. There will be "ruthless" companies with high
employee turnover, but we doubt that these will be
the most successful ones in the long term.
Employee, employer and customer loyalty is a
privilege, not a right.
Americans and
Europeans need to get their act together quickly,
as the rest of the world is not waiting. Consider
LG, the South Korean electronics giant. After
building a significant presence in much of Asia,
it has not only started to conquer the more remote
areas in China, but is ready to compete in the US.
Last fall, Home Depot started to push appliances
by LG aggressively; LG mobile phones are heavily
promoted in various US markets. Western companies
may have a very difficult time competing with
firms like LG that know how to operate profitably
on a large scale in Asia.
Unfortunately,
this discussion may be rather academic, as
fundamental change appears unlikely in the US and
Europe alike. In the US, there is such an
obsession with top-line growth that the
side-effects - including an ever increasing risk
to the stability of the dollar - may mushroom. And
Europe will always be slow-moving, and will not
become an agile competitor. Having said that, many
individual European companies have been able to
compete much more effectively; with further
reforms, these companies could become more daring
in expanding their businesses within Europe,
rather than shifting production abroad.
This does not mean that one cannot
negotiate hard with Asia to help level the playing
field. For example, the US or Europe could mandate
that imports be produced according to certain
environmental standards. Existing auto-industry
standards, which require a certain level of fuel
efficiency in cars and the presence of
pollution-control devices such as catalytic
converters, are one example of this approach.
Free-market advocates are always reluctant
to introduce such measures, as they can easily
become a back door to protectionism. In the end,
however, these are political questions that
elected officials should decide upon.
As
Asia is becoming more ambitious all the time, and
the fallout in the US and Europe more pronounced,
we are afraid protectionism may reign at the end
of the day as the standard of living in the West
comes under pressure. In the US, the risk is that
protectionist measures may scare away capital -
capital needed to finance the current-account
deficit and to keep the dollar from falling. In
Europe, the danger is that protectionist measures
will discourage further reform, worsening the
continent's competitive position even more.
Axel Merk is the founder and
president of Merk Investment LLC and the portfolio
manager of the Merk Hard Currency Fund,
a no-load mutual fund that invests in a basket of
hard currencies from countries with strong
monetary policies assembled to protect against the
depreciation of the US dollar relative to other
currencies.
(Copyright 2006 Merk Hard
Currency Fund. Used
by permission.)
